The melt down is getting even more dramatic as Europe yesterday had the worst single day drop ever and the S&P had the worst day since Black Monday in 1987.

There is a very high correlation between the performance of Investment Grade, High Yields and Equities and they are all blowing out. We cannot judge the equities performance  without analyzing the rest of the ecosystem which is composed by Commodities, FX, CDX IG & HY, Bonds, etc.  It is therefore impossible to talk about the state of just one asset class without knowing what’s happening to the whole ecosystem.

The Eurostoxx after the break of 2016 support and a 34.4% drop from highs it has reached the 2012/13 levels.

S&P after breaking the 200 weekly MA and dropping 27% from the highs, it has nearly reached the low of December 2018.

European futures are hovering around yesterday’s levels while US futures are up 2% from the cash close. Terrible morning in Asia, with Equity indexes triggering trading halts from Seoul to Bangkok, Manila, Jakarta and Mumbai. To note Japan -6%. Australia is the only positive market due to its Central Bank’s operation, the most important in years.

Italy, England and Spain have banned short selling from today.

As you can see from the chart below, most countries are in the acceleration process but investors fear is already at peak.

The fall in European equities from the top in 2007 until the lows of the credit crunch in 2009 was -62%, the whole correction took  21 months! From the highs this year until current lows is a pullback of 32%in just 3 weeks!

As we always said, the players of course are different and liquidity is different but in those days it felt like the financial system would not survive and the world would collapse in front of our eyes.Now we are almost certain that the world WILL survive COVID-19.

Yesterday stocks have been underperforming 10Y Yields by nearly 4 standard deviation, a very rare situation. As we explained yesterday, the market melt-down is happening on all asset classes. Have a look at Gold which it should have been up over the last days and has instead lost 4.5%.

Within all investors, the one currently suffering the most are the Risk Parity funds which combines stocks, bonds and other financial assets. These funds are basically enhancing the correction as they are selling both equities and stocks at a quick pace now and their flow can reinforce correlation breakdowns like we are seeing here. Those funds are down 8 /10% Wtd, the worst period since the existence of these funds.

It is important to note that while the equity market is collapsing with a decent liquidity (not great but it is possible to trade big caps and decent quantity of futures), on Equity Small caps and Bonds the market is basically nearly halted.

S&P futures reveals that the top of the book depth is at 1.5mln$, 95% below the long term average.

The US Treasury market is the world’s risk free rate and allows the US government to fund itself. If the US Treasury market experiences large scale illiquidity it will be difficult for other markets to price effectively and could lead to large scale position liquidations elsewhere. The bid/ask spread in off the run 30Y bonds usually trades a 4/32nd bid/offer, yesterday it was points wide.

In the loan market, prices on even the most highly-traded names are highlighting the market dislocation with huge bid/offer spreads. The trading difficulties are exacerbated by many traders working from home and from off-site locations to avoid the spread of the virus. It is very difficult and expensive to create cash from portfolios. It is exactly the opposite issue we had just a month ago when nobody wanted to hold cash because of negative rates!

Risk is becoming increasingly hard to manage which may finally bring in Retailers and all the residual passive holders which have bought aggressively at the beginning of the year and may come only when individuals are forced to stay home, not get paid and scared about the general picture. It doesn’t really matter but even Bitcoin is falling apart, down 40% in a two days.

The ECB response wasn’t taken too well by the market. The left rates unchanged and boosted QE adding 120bn of net asset purchases through the end of 2020. They also announced a TLTRO III which is a huge benefit for Italian banks. Banks can borrow MRO-25 and earn as much Deposit-75. The increase to 50% increases TLTRO capacity in Italy to 135bn from 90bn before this announcement. You would have expected banks to bounce but they infact dropped further.

So, what’s the verdict? The ECB clearly has understood the challenge at hand, which is good news, but the package such as presented above leaves a lot of uncertainties. Yesterday evening the EU commission said that will unveil today some measures package.

The Fed promised to inject above $5.5 trillion in the market, to stabilize the short-term funding segment. $500 billion 1-, 3-month repo operations will take place every week. Another QE is coming? The Fed will do what is necessary to keep the funding markets functional and is very much aware of the liquidity-impaired environment in Treasuries (-96% liquidity).

Asian central banks are preparing to flood the market with massive extra liquidity: The Bank of Japan agreed to an emergency meeting after buying $5 billion through repo operations, Australia’s central bank injected $6 billion, Indonesia’s central bank is buying its own government bonds, China will inject more cash into the economy while Bank of India will tap a record $481 billion in foreign reserves to keep the FX stable.

 NY Fed injected almost $200 billion into the short-term financing system Thursday through repo operations, each oversubscribed. In the chart below, you can see the yellow bars up to the highest levels, which means that banks are eager to have more and more liquidity.

The confirmation that there is a funding shortage in the interbank market is given by the next two chart, respectively FRA/OIS (key gauge of banking-sector risk) and the Global basis Swap (massive dollar shortage) which crashed down since the great financial crisis.

FRA/OIS is touching 2008 levels…

Global Basis Swap

On a different topic, it is good to note that we should still have high volatility until the next expiry on the 20th of March as, thanks to the wild market moves, the experation is going to be one of the largest ever non December expirations!

The widely followed CNN indicator is showing maximum fear, something that is extremely difficult to witness!

Today’s Macro

  • Germany Inflation CPI
  • US Import/Export/Trade balance
  • US University of Michigan sentiment